Ben Ramanauskas has worked in academia and as an adviser to the government. He is currently writing a book on the UK economy
Although it has not yet been confirmed, it looks likely that Rachel Reeves will use her first Budget as Chancellor to announce changes to the UK’s ‘Fiscal Rules’ to allow for more borrowing. The rationale behind this is to allow the Government to increase investment but in a way that doesn’t further increase the tax burden on working people. While some of this is welcome, Reeves should still be cautious.
The Chancellor is right to advocate for more investment. If there are areas where it might not be feasible for the private sector to foot the bill and where there is a strong economic case for doing so—such as spending on public transport, energy infrastructure, and social housing—then Conservatives should welcome this.
Moreover, in many ways, it is helpful that Labour are open to tweaking the Fiscal Rules. Unfortunately, the previous Conservative government often treated the Fiscal Rules as if they had been given from on high and bodies such as the OBR as being sinister organisations attempting to undermine the democratically elected government as opposed to acknowledging that they are quangos created by the Tories and which could, in theory, be abolished.
What is more, it is encouraging that Labour wants to avoid hiking taxes on hard-working people and wants to allow them to keep more of their own money. The new government has announced that it does not want to see a return to austerity and tax rises are often the most damaging form of austerity given how they tend to crush economic growth.
Now, while all of this is true, it does not follow that the Chancellor should massively increase borrowing or that the commentators writing about potential ‘windfalls’ are correct. It also needs to be remembered that not all tax increases are as damaging as others. The Government should not pursue its likely course of hiking taxes on unpopular groups to avoid increasing the three ‘main’ taxes.
On the borrowing point, while scare stories about this leading to a spike in gilt yields or ‘crashing the economy’ are exaggerated and should be ignored, it does need to be remembered that any increase in borrowing is not ‘free money’ – it will increase the National Debt which already stands at 100 per cent of GDP and will need to be paid back.
A significant proportion of government expenditure already goes on servicing the National Debt. This will only increase if borrowing goes up. This is money that could be spent on essential public services such as the NHS, education, or defence.
Moreover, it is likely that sadly the UK has missed the boat when it comes to increasing borrowing. In the aftermath of the Global Financial Crisis, it was incredibly cheap for governments to borrow money. There is a legitimate debate to be had here over whether the UK government should have increased borrowing at the time – and it was not Labour’s responsibility at the time – but a government has to operate within the conditions and constraints it finds itself in. The era of very low interest rates is (probably) over for a long time.
This brings us to the taxation point. Labour was being extremely foolish when it decided to rule out any increase to Income Tax, National Insurance Contributions, and VAT. Doing so tied their hands so that when they got into power they would either have to increase borrowing or hike more economically damaging taxes such as Stamp Duty or Capital Gains Tax.
It also means that it allows the Government to avoid the difficult job of meaningful tax reform. For example, the Government could remove all VAT exemptions and levy the same rate on everything. This would massively boost the Treasury’s coffers and allow it to increase investment and cut more economically damaging taxes while also providing more targeted support for the very poorest households. Such a move would bring significant benefits.
Finally, simply deciding to increase borrowing to fund investment could tempt the Government to avoid implementing the necessary supply-side reforms to boost economic growth. As with tax reform, this would be politically unpopular, but measures such as liberalising the planning system and being prepared to take on the NIMBYs so that more transport and energy infrastructure and homes can be built will lead to economic growth and is something which a government with a massive majority should be prepared to spend its political capital on.
We do not know which target Reeves will use for its fiscal rules but it looks as though it has thankfully decided not to adopt Public Sector Net Worth (PSNW) and will likely target Public Sector Net Financial Liabilities (PSNFL) instead. While PSNFL is a more prudent option than PSNW, it still needs to be remembered that it won’t result in a windfall and any increase in borrowing will add to the national debt and will need to be paid back.
Does the country need more investment? Yes. Is Labour right to be creative and look into ways of doing this without tax hikes? Absolutely. However, simply borrowing more money is not the solution and will not be consequence-free. It would be much more prudent to increase investment and go for growth through a combination of tax and supply-side reforms.
